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Oil & Gas Law

Class 10: OGL (2 / 7) –

1. Primary Term2. Secondary Term [1 of 2]

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OGL Topic 2: Habendum Clause (a/k/a, Term)

From OGL Forms posted

TX form: Clauses 2, 5 & 6

KS form: Clauses 2, 3 & 8

Term has 2 parts: ________ and _________

Last Class … and this One …

OGL

Why this “Lease” isn’t really a lease

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L’or Drill producing wells

Drill well(s) sooner

rather than later

Receive as much $ as

possible

L’ee Drill producing wells

Hold the acreage for as

long as possible,

without drilling

Pay as little $ as possible

Primary Term – Basics

What is the typical PT duration?

PT: “… shall be for a term of __ years …”

What does this really mean?

Why doesn’t the Lessee get the entire PT to

drill?

What’s the mechanism for extending the PT?

What are the 2 methods used by the L’ee

to keep the OGL through the entire PT?

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Delay Rentals

2 kinds of Primary Term Clauses: _____ and

_________

What’s the difference between them?

Types and Distinction

“unless” clause – automatic termination of the

Lease unless the delay rental payment is made

“or” clause – lease doesn’t terminate, but failure to

pay the delay rental is treated as a breach and the

remedy is damages

Which is the more common? Why?

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Delay Rental Problems

ASSUME: an OGL with an “unless” delay

rental clause … does the OGL terminate?

1. L’ee makes out a check and mails it in a

timely manner, but the P.O. delivers it to the

wrong house, and the recipient tosses it

2. L’ee makes out the check, but the person

who’s job it is to mail it unexpectedly goes into

labor, and the check sits on her desk for 3

months until she returns from maternity leave

3. due to a typo, L’ee pays $1,001.99 instead of

$1,010.99

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Schwartzenberger v. Hunt Trust Estate

Which kind of delay rental clause was in

the OGL?

What was the mistake and who caused it?

Surface acres vs. “Mineral acres”

PP. 215-218 N1 & 3

Proper amount / person / manner

Received on or before the due date

Whether or not equity applies

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Delay Rentals

A very common practice: do a paid-up lease

[ see KS Form, cl. 3 … & p. 223 N8 ]

What is a “paid-up lease”?

What are the benefits ??

What are the detriments ??

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Savings Clauses (p. 222, N7)

Does Clause 1 work?

No

Does Clause 2 work?

It should, but …

Does Clause 3 work?

Yes it did

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Drafting Pointer

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Primary Term:

Another Way to Save the OGL …

Drilling!!

L’ee can drill during the initial part (e.g., 1st yr.) of

the PT and avoid paying delay rentals

TX form, CL. 5: “If operations for drilling are not

commenced … on or before one year from the date

hereof, the Lease shall terminate … unless [pymt of

D.R.] …”

Based on that language (and the Breaux case),

what constitutes “operations for drilling”?

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Primary Term – Drilling

Which of these activities (if any) constitute

“operations for drilling”? 1. Building a road on the leased lands

2. Building a road on lands adjacent to / nearby the

leased lands

3. Putting up a sign on a stick that says “future home

of the Smith #7 well”

================================== 4. Filing with the applicable state agency an

application for a drilling permit

5. Ordering equipment that could be used on several

wells

6. Ordering specialized equipment that could only be

used on this well

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Primary Term – Drilling

Which of these activities (if any) constitute

“operations for drilling”?

7. Staking out the drilling rig’s location 8. Contracting for a drilling rig to drill the well 9. Using a drilling rig to drill a water well to use

in the drilling of the O&G well

==================================== 10. Obtaining financing 11. Wiring the leased lands for electricity

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What if a Lessee waits until 11:57 PM on the last day of the primary term to commence operations for drilling?

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Primary Term – Drilling

3 factors to consider – see N2 p.228 Should waiting until the last day (or close to

the last day) raise an inference on L’ee’s good / bad faith?

When it comes to paying delay rental payments, the courts (as we have seen) are very strict … and yet, when it comes to “commencement of operations for drilling”, the courts are more liberal; Why?

If a Lessor didn’t want to subject itself to the vagueness of “commence for the operation of drilling”, how should the Lessor modify the Lease form?

Primary Term – Drilling

What if L’ee drills during the PT, but it

drills a dry hole?

Ex: 3-yr PT, from Jan. 1, 2011 Jan. 1, 2014

L’ee drills dry hole during Aug.-Oct. 2012

If L’ee does wait until the end of PT, it is

given a period of time to complete its “drilling

operations”

SEE: TX OGL Form: Clause 6 (2nd half)

SEE: KS OGL Form: Clause 8 (1st half)

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Secondary Term

The trickier (conceptually) of the 2 parts of

the term

Term Clause:

Primary Term: “… for a term of ___ years …”

“and for so long thereafter as [ something

occurs ]”

There are several ways to maintain the OGL

into and through the Secondary Term

Tonight: production

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Secondary Term – Clifton v. Koontz

Will any production extend the OGL Term?

Does “production” mean the same thing as

“production in paying quantities”? (PiPQ)

What does “PiPQ” mean?

Is paying quantities = commercial quantities?

What kinds of deductions did the Petitioners

argue should be considered? Ct ruling?

What about RRC Orders … should they be

considered? What kind of Order was

involved here?

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“Production in Paying Quantities”

Example:

Cost to drill and complete: $5,000,000

-------------------------------------------------------------------

Cost of continuing operations: $ 70,000 /mo.

Overhead / G&A: $ 20,000 /mo.

Royalties to L’or (1/8) $ 9,375 /mo.

-------------------------------------------------------------------

Sales revenue: $ 75,000 /mo.

------------------------------------------------------------------

Is this well producing in paying quantities?

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“Production in Paying Quantities”

Essentially a 1- or 2-step process [ p. 237 N3 ]

First: is there a profit? If yes, the analysis is over

Second, if no, then you examine whether or not a reasonably prudent operator would continue

What sorts of factors might go into the Lessee’s decision?

Over what period of time must the well produce “in paying quantities”? Monthly? Quarterly? Annually?

Look at N4 pp. 238 – 241 re other kinds of expenses

If a Lessor wanted more specificity or clarification, how might they modify the OGL?

Some possibilities:

“production sufficient to continue operations in Lessee’s opinion”

“production sufficient to generate a royalty payment to Lessor of at least $___ per year”

“Production in Paying Quantities”

An OGL is a business transaction, not

an arrangement entered into for

political or social objectives; t/f, L’ee

MUST BE making $$$

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Post-Termination

P. 242 N8 – “Equipment Removal” Clause

SEE: TX OGL Form: Clause 7

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OGL – Terms

Primary End Secondary

Primary Term Pay Delay Rentals

Drill

PTST: “PiPQ”

Comm. Drlg Ops

Secondary TermProd. /// Shut-In Royalties

TCoP /// Imp. Cov.

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Next Class (CL 11) …

Continue Topic 2: Term

The other ways that the secondary term

can continue in effect

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Ch. 2 Sec. 2 (b) and (c)

PP. 243 – 278